Forecasts put strong dollar even higher

The "stratospheric" dollar is expected to head even higher and average around US86 cents this year, according to latest Westpac Bank forecasts, hurting the export sector.

"With the New Zealand economy the best of a bad bunch, we may see the currency strengthen further through 2013," Westpac said.

The dollar would push up against the Australian currency to the mid-A80 cents range, Westpac said, with the expectation that the New Zealand economy would grow faster than Australia's for the first time in many years.

The New Zealand economy was expected to grow about 3 per cent this year, as the investment boom from quake rebuilding hit its straps while the Australian mining investment boom began to slow.

The dollar was trading at US83.5c yesterday and at A81.5c, a level last seen in mid-2010.

The higher currency was expected to further dampen inflation in the near term and added to expectations that the Reserve Bank will hold the official cash rate till December.

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The OCR was expected to rise from 2.5 per cent now to 2.75 per cent in December, heading to 4.5 per cent by the middle of 2015, according to Westpac.

Westpac chief economist Dominick Stephens said the economy was starting to move as the Canterbury rebuild hit its straps.

"But the stratospheric exchange rate has kept inflation in check," he said, so the Reserve Bank had been able to keep the OCR low.

The predictable result was rising house prices and consumer confidence.

After rising about 6 per cent in the past year, house prices were tipped to increase another 9 per cent this year, slowing to 4 per cent in 2014.

While interest rates were low, house prices were rising and the economy was picking up, the "Goldilocks moment" would not have a fairytale ending.

"The high exchange rate is hurting New Zealand's international competitiveness."

The booming construction sector would in time put inflation pressures on the economy.

"The eventual circuit-breaker will be higher interest rates," Stephens said. "And when that happens there could be a nasty downturn in house prices."

If the Reserve Bank started to raise the OCR late this year house prices would start to look overvalued "and boom could eventually turn to bust", he said.

The momentum in the housing market depended crucially on "ultra-low interest rates". But interest rates would have to rise more than financial markets were expecting and that would hurt the housing market .

By 2015 the Christchurch rebuild would hit its peak and interest rates would be rising as domestic inflation pressures became widespread.

That meant stronger economic growth for now, of 3 per cent this year and 3.2 per cent in 2014, but slower growth from 2015 onwards.

"The Christchurch rebuild is the linchpin of this story and its pace and timing remain uncertain," Stephens said. Reserve Bank estimates put rebuild costs at $30 billion, but Westpac took a more conservative line of $27b.